Air-conditioning

1
Air-conditioning Refrigeration Industry Pre
- Budget Memorandum 2003-04
RAMA
13 December 2002, New Delhi
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SUMMARY OF KEY MESSAGES- AIR-CONDITIONERS, 1

• The Indian AC market size is Rs 2,790 crore
  comprising the household and commercial segments.
  The market is currently at a nascent stage and
  shows tremendous promise to grow. However,
  despite the reasonable growth in the last few
  years, the growth potential has not been entirely
  captured.
• The key bottleneck to growth is the low
  affordability of ACs. This is clearly evidenced
  in the Chinese market where substantially low
  price points (less than 50 of Indian retail
  prices) have driven penetration of ACs.
• In order to capture the growth potential, a
  substantial reduction in price is required. The
  primary cause for the high prices is the high
  incidence of indirect taxes, excise duties and
  import duties on the product category
  accounting for close to 45 of the MRP. In
  particular, the abnormally high excise duty of
  32 is a major deterrent to growth.
• With government support in duty and tax
  rationalization, the AC market can grow very
  rapidly over the next 5 years to as much as Rs.
  14,000 crores by 2007. Reducing excise duties,
  indirect taxes and import duties is a win-win-win
  solution for the government, players and
  consumers.
• The specific short term proposals include
• A reduction in excise duty from 32 to 16 with
  40 abatement beginning March 03
• Excise exemption in certain states such as Jammu,
  North East to be repealed as they destroy value
  for government, players and consumers and confer
  none of the intended benefits to the system
• A reduction of import duty to 25 for finished
  goods and 15 for components beginning Mar-03

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SUMMARY OF KEY MESSAGES - COLD CHAIN, 2

• Agriculture has been recognised by government as
  a focus area
• Cold chains (84.18) are a vital part of the
  agricultural chain
• There is a huge unrealised potential for
• Preserving food and dairy products
• Improving food distribution
• Reducing cost of food to the common man
• Cold chain enjoy excise exemption. however,
  CENVAT credit on inputs is not available
• To maintain the spirit of exemption from
  incidence of taxes, replace exemption to cold
  chain by refund/ subsidy

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THE INDIAN AIR-CONDITIONING INDUSTRY IS A Rs
2,790 CRORE MARKET
Segment
Value
Volume
Applications
Window ACs
Rs 1200 crore
540k nos
Homes, SOHO
Major players
Mini Split ACs
Rs 730 crore
220k nos
Homes, offices, shops, showrooms

• Amtrex Hitachi
• Blue Star
• Carrier Aircon
• Daikan Shriram
• LG
• Samsung
• Voltas
• Whirlpool
• OGeneral
• Matsushita

Ducted Split and Packaged AC
Rs 400 crore
216k tons
Commercial establishments
Chillers and Central Plant
Rs 460 crore
272k tons
Industrial, institutional and large commercial
Rs 2,790 crore
Industry investment in line with potential
resulting in surplus capacity leading to
oversupply and price wars
Source Francis Kanoi Industry estimates
5
THE RESIDENTIAL SEGMENT IS FAST OVERTAKING THE
COMMERCIAL SEGMENT IN RAC WHILE THE PACKAGED AC
HAS WITNESSED LIVELY GROWTH IN RECENT PAST
Packaged AC displays, thrice the growth of GDP
Increasing share of domestic segment in RAC
000 Tons
Estimates
Commercial
14
Actual
Residential

• Easy Availability of comprehensive range of
  ducted splits and ductless flexible PAC system
  improved affordability will drive future growth
  on the back of high growth in IT, healthcare,
  retail, telecom, financial services,
  entertainment, leisure tourism and other
  services sectors.

• Growth of residential segment driven by higher
  affordability and disposable income, changing
  lifestyle in perceiving AC as need rather than
  luxury
• Residential segment expected to drive growth of
  RAC eventually will increase share gt80 as in
  the most markets

Source Francis Kanoi Industry estimates
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TREMENDOUS POTENTIAL FOR HOUSEHOLD AIR
CONDITIONER MARKET TO GROW, GIVEN LOW PENETRATION
Very low penetration
Leading to huge untapped potential of 83 mn
Per cent of all households
Million
Taiwan
182
0.1
180
64
1.8
1.7
Hong Kong
61
Korea
33
Small towns and Rural
144
3
144
28
Multiple ownership
Malaysia

83
5
Thailand
55
China
Urban
38
36
28
Indonesia
Total HH
HH with refrigerators
Untapped potential
Unelect-rified
Below poverty line
Untapped potential
India
After removing households below poverty line and
in uncertified areas
Source Francis Kanoi NCAER
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HOWEVER GROWTH IS LOWER THAN POTENTIAL AS AC IS
VERY EXPENSIVE PURCHASE EVEN FOR HIGH INCOME
CLASS (1/2)
Price income multiple for ACs in China
Sizable population in India finds ACs expensive
Price/ Monthly income multiple
Income class
Income class
Untappedpotential
P/I multiple
Penetration
Penetration
Per cent of all HH
_at_ price of Rs.21,000
HH mn
Per cent
MHI
Bottom 40
Up to 12,000
Next 20
12,000 16,000
Next 20
gt 16,000
Next 10
Top 10
After removing households below poverty line
and in unelectrified areas Based on Urban
population Monthly household
income Source Francis Kanoi IMRB NCAER
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HOWEVER GROWTH IS LOWER THAN POTENTIAL AS AC IS
VERY EXPENSIVE PURCHASE EVEN FOR HIGH INCOME
CLASS (2/2)
Growth has been lively in household air
conditioner market but less than potential
Value
Volume
Rs. Crores
000 units
25
9
31
30
18
17
26
31
1995
1998
2000
2001
2002
1995
1998
2000
2001
2002
Source Francis Kanoi, ORG-GFK
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THE HUGE DIFFERENCE IN RETAIL PRICES BETWEEN
INDIAN AND CHINESE ACs EXPLAINS THE LOW
PENETRATION, DEMAND
This explains difference between Indian and
Chinese statistics
Chinese retail prices are more than 60 lower
than Indian retail prices
Domestic market
Type of AC
Indian price
Chinese price

• India 0.3 mn units
• China 14 mn units

US
US
Penetration

• 1 Ton window

360
136

• India 1
• China 20

• 1.5 Ton window

420
185
Exports

• India Insignificant
• China 5.9 mn units

• 1 Ton split

555
199
GDP

• 1.5 Ton split

635
280

• RACs contribution to GDP in China is 4 times
  that of India

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. . . AND CHINA EMERGED AS LARGEST MANUFACTURER,
EXPORTER OF RACs ON BACK OF LARGEST DOMESTIC
MARKET

• In the last decade the Chinese RAC market has
  grown from 6 to 23 times the Indian RAC market,
  despite Per Capita PPP differential of only 1.7
  times
• Today China is the largest manufacturer
  exporter in the world with a CAGR of 46 in last
  11 years
• China leading due to
• Economic reforms, localisation of ancillaries,
  dominance of domestic brands and entry of MNCs
• Lower Prices leading to increased affordability
  single VAT of 17.
• Export competitiveness due to large Scale
  operations for domestic market itself

China
India
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
Source Appliance Magazine
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THE HIGH INCIDENCE OF INDIRECT TAXES AND DUTIES
IS THE PRIMARY CAUSE FOR THE HIGH PRICE POINTS
Effect of government policy
Typical 1.5 ton window AC
Rs
22000
21000
1000
1170
46 - Rs 9,715
4215
54 - Rs 11,285
3395
1000
Duty effect
1000
2105
8115
Manufacturing cost
Manufacturing margin
Freight, warranty
Sales tax, octroi
Excise duty
Channel margin
Consumer price
Discount
MRP

• High import duty 30 for key components

• Weighted average range of 12-21
• Octroi/entry tax of 3

• 32 with 40 abatement
• AC is still perceived as luxury

Source McKinsey Analysis Interview of Players
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THE LOW ABATEMENT IS NOT IN LINE WITH THE HIGH
POST MANUFACTURING COST NOR IS THE EXCISE DUTY ON
PAR WITH OTHER WHITE GOODS

• Highest rate of ED and sales tax amongst white
  goods
• ACs 32 ED on 60 of MRP sales tax of 21
• Refrigerator 16 ED
• Driven by perception of AC as a luxury today,
  AC is a need especially in a tropical country
  like India
• Further, amendment in the CST Act, almost all AC
  sales subject to LST which is higher than
  refrigerators
• Abatement of 40 not in line with high post
  manufacturing costs
• Post manufacturing costs of AC is 52.7 of MRP
  leaving a gap of 12.7 (given abatement of 40)
  on which no abatement

Source Industry Sources
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THROUGH CONTINUED EFFORTS BY PLAYERS BACKED BY
GOVERNMENT SUPPORT SUPPORT, THE INITIAL PRICE OF
AN AC CAN BE BROUGHT DOWN DRAMATICALLY
Typical 1.5 ton window AC
Rs
21000
4600
2300
3100
11000
Current price
Cost reduction effort by players thru design,
scale anciliarisa-tion
Reduce excise duty to 16
Rationalise indirect tax and import duty structure
Final possible price

• Single VAT of 15
• Single import duty of 10 across value chain

Source McKinsey Analysis Interview of Players
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REDUCING EXCISE DUTY ON ACs FROM 32 TO 16 WILL
BE TAX POSITIVE FOR THE GOVERNMENT
Current tax revenue indexed to 100
Price elasticity for ACs
Price (Rs)
Current tax rev. (ST excise 35)
Total loss due to decrease in tax rate at current
volume
Offset due to increase in demand at reduced price
Net loss due to lowering excise duty to 16
Tax revenue potential (intermediate)
Gain due to increased compliance
Reduced costs due to scale leading to reduced
prices and increased demand at new duty levels
Total revenue potential
X
Volume (000 unit)
Price elasticity of 3, meaning a 30 drop in
price will result in 100 increase in volumes
Source McKinsey Analysis Interview of Players
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FURTHER, MOVING TO SINGLE VAT AND IMPORT DUTY
WILL NOT AFFECT TAX COLLECTION ADVERSELY
Price elasticity for manufactured goods
Change in tax revenues
Current total tax revenue indexed to 100
Refrigerators
Color TVs
Direct Tax gain due to increas-ed sales
Gain due to increas-ed compl-iance
Gain in duty revenue due to higher consum-ption
Total Rev. poten-tial
Company driven actions to lower prices, hence
improve demand and tax collections
Reve-nue poten-tial
Current tax rev ST Excise -25 C.Duty 24
Loss due to lowering VAT to 15
Loss due to lowering duty to 10
Tax revenue after reduct-ion in rates
Indirect Tax gain due to increas-ed sales
Price/Income
Gains in tax revenue
Gains in duty revenue
SourceCII-McKinsey Study on Learning from China
to Unlock Indias Manufacturing Potential
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THE FINAL OUTCOME WILL BE A WIN-WIN-WIN SITUATION
FOR PLAYERS, GOVERNMENT AND CONSUMERS

• Domestic AC market can be a huge market by 2007
• Size of domestic market Rs 6280 crore and 4.3
  million units with further growth possible
• Increased standard of living for consumer
• AC will become a need and productivity enhancer
• Growth in exports will earn foreign exchange for
  country
• Scale in domestic market will drive
  competitiveness in exports (e.g., Chinese exports
  of 5.9 million units driven of domestic volume of
  14 million units)
• Household AC exports can be Rs 700 crore

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ON THE OTHER HAND, NOT IMPLEMENTING INITIATIVES
WILL CONTINUE TO HAMPER INDUSTRY PROFITS AND A
MAJOR OPPORTUNITY WOULD BE LOST
Price (Index 1998 to 100)
Price cost squeeze adversely affects players
profitability
Total variable cost(Indexed 1998 to 100)
Source Analysis
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PROPOSALS TO GOVERNMENT - EXCISE DUTY, 1
Excise duty rates and exemptions

• Excise duty rates - Air-conditioners (84.15)
• Excise duty and abatement to be brought on par
  with white goods (16 excise duty and 40
  abatement) effective March 2003
• Excise duty exemption
• Excise duty exemption to SSI to be withdrawn as
  it has outlived its purpose large gap between
  the duty payable and the input duty is a
  potential threat for leakage in revenue
• Locational exemptions for manufacturing in
  North-East and Jammu for air-conditioners to be
  repealed as this has led to creation of
  finishing, packing invoicing hubs, adding to
  fragmentation of manufacturing and inability to
  capture scale economics
• This exemption destroys value for government,
  players and consumers and confer none of the
  intended benefits to the system
• The exemption is financially attractive due to
  large gap between duty payable at 32 and all
  inputs at 16 with no requirement of value
  addition or minimum employment. In fact
  air-conditioner is the exception and not covered
  in the negative list
• If existing notification cant be repealed,
  amend the notification by adding
• condition for value addition
• criteria for investment/employment

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PROPOSALS TO GOVERNMENT - EXCISE DUTY, 2
Excise exemption for Cold Chain (84.18)

• Cold chain enjoys excise exemption under General
  Exemption No 66 in List 44
• However, CENVAT credit on inputs is not available
• To maintain the spirit of exemption from
  incidence of taxes
• cold chain may be covered under payment of excise
  duty at 16
• grant refund of Terminal Excise Duty (TED) to
  manufacturer or
• grant additional subsidy, equivalent to excise
  duty, to user

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PROPOSALS TO GOVERNMENT- CUSTOMS DUTY, 1
Customs duty

• Broadly in agreement with the recommendations of
  Kelkar Committee
• 2003-04
• 25 on finished goods and
• 15 on raw material, inputs and intermediate
  goods
• By 2004-05 2 tier structure with
• 20 on final goods and
• 10 on raw material
• By 2006-07 single 10 import duty across value
  chain
• Recommend equal reduction of 10 in rate of
  custom duty to meet the target rates.

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Thank You